Westport To Benefit As U.S. Transport Industry Switches To Natural Gas

Westport Innovations (NASDAQ:WPRT), the global leader in natural gas engines, reported its second quarter earnings last Friday. As predicted by Qineqt, the company beat earnings and revenues. The stock went up by 13%, as the company gave an outlook of a 50% growth for the rest of the year.

All three main businesses of the company, namely Cummins-Westport Engines (CWI), Heavy Duty trucks (HD) and Light Duty (LD) trucks, showed remarkable growth over the year. Total shipments displayed over a 100% growth rate YoY. Margins were also seen on a rise. The only exception was CWI's margin, which declined after incorporating the warranty adjustments.

The management claims that key segments of the Transport Industry have started shifting from diesel and gasoline driven engines to natural gas engines. As the rate of transfer from diesel to natural gas engines rises, the stock is expected to benefit significantly. The main reason behind missing the earnings this quarter is the growth in all three segments of the business, which became possible after the industry started adopting natural gas as a source of fuel.

Some important concerns in the earnings call were the status of WPRT's current strategic alliance with different companies, the rising competition in HD LNG truck markets and WPRT's approach towards growth in Asia, especially China, from where the company makes 14% of its current revenues.

Investment Thesis

WPRT is a global leader in natural gas engines. The company is expected to make a fortune once the Transport Industry shifts to natural gas as a source of fuel. Given the wide difference between the expensive gasoline and the cheap natural gas, as well as the recessionary times where firms are doing everything to control costs, WPRT, with its expertise in natural gas engines and strategic alliances with major OEMs, holds a genuine chance to benefit from the potential change in the energy landscape of the U.S.

Press Release

WPRT finally beat earnings and revenues this quarter, after missing them in the last three consecutive quarters. The future guidance for revenue was maintained by the company at the same level, which is $400-$425 million, showing an overall YoY growth in revenue of around 50% from the previous year's figure of $270 million. The company also maintained the outlook for a 50% growth in earnings for the year.

Financial Performance and Future Outlook

Following shows the overall YTD performance of WPRT.

The table shows that all three businesses grew exponentially in this year. For a detailed analysis on what each business offers, refer our article on WPRT. The margins have also improved as WPRT has made different alliances to capture as much a market share as possible. Only CWI margins have declined because of warranty adjustments. After adjusting for warranties, CWI margins turn out to be 39%. The increase in revenues shows how the Transport Industry is gradually shifting towards the cheaper source of fuel.

Following shows the percentage of revenues coming from each stream and how it has evolved over the last couple of years:

(click to enlarge)

The chart shows that CWI has by far been the major business of the company. However, the trend shows that the LD business is growing in size day by day, as WPRT is actively trying to penetrate this vast market.

LD Business

According to the historical figures, more than 90% of the vehicles sold globally are light duty vehicles. Therefore, WPRT has a big market to target. Following chart, taken from the company's presentation, shows the market for LD in North America.

The following chart shows the sales from the LD business:

(click to enlarge)

The chart shows the rising trend of LD revenues.

In order to grab the opportunity, WPRT has made partnerships with several OEMs like Volkswagen (OTCPK:VLKAF), Fiat (FIATY), Peugeot (OTCPK:PEUGY) and Ford (NYSE:F). Notable acquisitions include AFV, the Sweden-based supplier of natural gas systems. Through this channel, WPRT provides CNG systems to the Volvo Car Company. Another important deal is with General Motors (NYSE:GM), in which both will collaborate to produce advanced natural gas technology for light duty vehicles.

Currently, Europe is the only place that is giving a tough time to WPRT sales. For further penetration in the global market, WPRT will have to come up with newer and cheaper products. With a leading CNG intellectual property portfolio, WPRT is expected to make big gains once it establishes itself in the global market.

The sell-side claims that future growth in the LD business has not been priced in the stock, and will happen once WPRT comes up with cheaper and newer products.

HD business

The market for HD LNG trucks did not grow at the rate that was expected by the market. However, still revenues for the division were greater than those of the previous year. 75 HD engines were shipped as compared to 17 units in the same quarter previous year. However, this is far below the breakeven target of 1,200 units. The rise in HD sales is primarily attributed to a $6.1 million rise in revenue from engineering services, which are a direct outcome of the Volvo agreement. Also, the pricing has not been favorable as new competitors like Cummins (NYSE:CMI) and Navistar (NYSE:NAV) have entered the market.

The sales of HD trucks depend a lot on the fueling infrastructure in North America, which is far from satisfactory. There are only 54 CNG stations in the U.S. and a majority of them are in California. Companies like Shell (NYSE:RDS.A) and Clean Energy Corp (NASDAQ:CLNE) are actively involved in building more fueling pumps in the U.S. WPRT has a positive outlook for this year for HD LNG trucks.

High Horse-power Technology (HHP)

WPRT is working with Caterpillar (NYSE:CAT) to produce natural gas engine technology for off-road equipments. The technology will use HPDI engines. The engines will be prepared for mining equipment and marine and rail transport. CAT is heavily funding the project. The first product will be a locomotive for the Canadian National Railways (NYSEARCA:CN), which is expected to be rolled out by 2014. If successful, a great opportunity lies in this technology, as the divergence between oil and gas prices continues to rise.

WPRT in China

Following shows the geographic bifurcation of WPRT's revenue:

(click to enlarge)

The chart shows that WPRT's revenues face almost a 35% international exposure. A major chunk of that is formed of the Chinese sales. WPRT has made an alliance with Weichai Power, one of the leading natural gas engine suppliers in China, in order to penetrate the market. Following shows the performance of the joint venture:

The decline in margins is because Chinese consumers being more price conscious as compared to U.S. consumers. Therefore, WPRT has to charge lesser in order to increase the market share. WPRT has planned well to address the rising Chinese natural gas trucks market. WWI production capacity has been expanded to 40,000 engines per year. Also, WPRT's HPDI engine is undergoing road testing with OEM supplier Shaanxi HD automobile. The engine is expected to be launched by 2013.

Valuation

With a 50% growth expected this year and a 30% growth rate per annum expected for the next five years, the stock is a very impressive growth story. The stock is trading at cheap multiples, as the economy is uncertain of the shift of the Transportation Industry to natural gas. As the U.S. infrastructure for natural gas stations improves, the stock is expected to go up. Currently, the earnings are expected to go positive in 2015.

*At current price

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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